Newland's Business Notes

Franchising:  Is it For You? Part II

Volume 8 Issue 3 -- May/June 2004

In the last issue of this newsletter, we looked briefly at what franchising is all about. In this issue, we will explore how to tell if a franchise is right for you.

Franchises, as a business opportunity, have some advantages and disadvantages.  One common advantage of franchises is that the franchisor places national or regional ads which benefit all of the franchisees.  Nearly all fast food franchises of any size have national media outlets which promote the franchise in the media and at major sporting events.

Franchisees benefit from the national exposure and the chance to get their product or service known to many more people than would be possible with only local advertising. But what if the franchisor runs into cash flow problems and fails to do effective national marketing? In such cases, the interdependency of the franchisee and the franchisor becomes critical.

This is why it is imperative that anyone thinking of purchasing a franchise must thoroughly investigate both the franchise offering and the franchisor. 

Investigating the Franchisor

One of the required disclosures in the Uniform Franchise Offering Circular is financial statements of the franchisor.   These must be carefully studied to make sure that the franchisor will have the financial ability to live up to its end of the bargain.

A well run and well organized franchise system can help an entrepreneur get started and succeed in business with less capital and experience than might otherwise be required.  On the other hand, there are some very definite risks associated with franchises which a potential franchisee must fully understand.

From the standpoint of a potential franchisee, the task of doing due diligence in investigating the franchise offering involves many components. For example, if there are other competitors, whether franchised or not, in the same area offering the same or similar products or services, such as home inspections, how will a franchisee succeed? Will the franchisee be competing with other franchisees of the same brand? 

The decision whether to market a business through a franchisor is a difficult choice to make, involving a complex interplay of legal and economic factors.  The guidance of an attorney and an accountant knowledgeable about franchise matters is essential.

The trade-off for the benefits of a franchise — a national brand and guidance and marketing support from the franchisor — is the cost of paying a percentage of sales to the franchisor and giving up considerable control to the franchisor. 

Franchise agreements often require franchisees to follow strict rules about the operation of their business as well as to incur various financial obligations. It is essential that any franchisee fully understand, before anything is signed, the obligations (financial and otherwise) that are imposed by a franchise agreement.

We all know businesses or restaurants that sell a particular service or product and do well without the need for the support of a franchisor. One advantage of being successful without a franchise is escaping the constant payment of the royalty to the franchisor, which means that the non-franchisee gets to keep a greater percentage of the gross receipts. 

In the last issue, we talked about the need for a business plan.  This is particularly important for a franchisee, because the franchisee may be contractually obligated to incur a number of expenses to the franchisor and have little control over reducing such expenses.

Control By Franchisor

The franchisee must also realize that many decisions regarding the operation of the business will be made by the franchisor.  For example, Hen Doodles (hereafter “Hen”), requires its franchisees’ employees to wear red hats looking like chicken combs. If one franchisee thinks this is ridiculous and refuses, Hen may contractually force the franchisee to comply or terminate the franchise. 

Both franchisors and franchisee sometimes fail, for a variety of reasons. If the product is defective or if the franchisor does not properly manage the franchise effort, the entire franchise may fail. If that were to happen, the franchisees essentially have lost their money.

Franchisees, even with successful brands, can also fail, because of poor planning or poor execution. In that respect, franchises are like most other small businesses. Good planning is always essential.  

Copyright 2004

Published by the law firm of Newland & Associates, PLC
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